HEC Research Papers Series,
HEC Paris

Abstract: This paper examines the fair value management of Employee Stock Options (ESOs). Departing from earlier literature focused on input estimates, we study management of the valuation model itself, seen in the ad-hoc adjustments made by companies to generally accepted models. Our analysis is based on a unique sample of ESOs in an IFRS context for which detailed disclosure is available. We find evidence of model management, with a median understatement of 52% compared to our benchmark model, which is designed to control for ESO-specific characteristics and input estimates. Furthermore, we identify three levers for model management: dilution, non-tradability of the option, and transaction costs. We conduct an in-depth analysis of companies’ arguments for making these ad-hoc adjustments and find no grounds for them. This paper highlights model management as a relevant issue for ESO fair value which has direct consequences for standard setters and enforcement authorities.

Keywords: Fair value; ESO; Transaction costs; IFRS 2; Dilution; Non-Tradability

JEL-codes: G13; G30; J33; M12; M41

56 pages, September 1, 2015

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